Rising oil prices seen as long-term play on energy

MurrayColeman

SAN FRANCISCO (MarketWatch) -- With energy prices facing a perfect storm, some money managers are stocking up on some of the biggest and most diversified oil companies in the world, believing that prices could march further above the $80 a barrel record reached this week.

"Expectations are that through the end of the year, as winter sets in, global demand will pick up even more," said Evan Smith, co-manager at U.S. Global Investors Global Resource Fund
PSPFX, -1.77%

This bullish view looks past an already relentless rise in energy stocks. The benchmark Amex Oil and Gas Index
XOI, -0.99%
is up a blistering 200% over the past three years, embarrassing a host of analysts that have tried to call the peak in this long-legged rally.

Meanwhile, several major projects are facing delays that promise to limit new supplies. Analysts are also finding that oil production in the Gulf of Mexico seems to be declining faster than anticipated.

Add a weak U.S. dollar into the picture and prospects don't seem ripe for significant relief right away in oil prices.

"A weak dollar is also making it more expensive for OPEC producing countries to profit when selling in overseas markets," Smith said "It hurts their purchasing power and means they need higher prices just to maintain existing profit levels."

The veteran fund manager says oil prices could keep going higher, although he doubts that $100 per barrel is in the cards anytime soon. But still in the midst of hurricane season, some sort of natural disaster along the U.S. Gulf Coast could exacerbate demand and supply imbalances even more.

However, stock selection in the energy sector is still mandatory. An issue in coming months is the market for natural gas, where prices are lagging due to flat demand, high inventory levels and growing production.

Managers at the U.S. Global Investors fund are staying away from North American natural gas producers for those very reasons.

Instead, they're moving into larger integrated oil exploration companies. Most are global players and large enough to weather any clouds forming in the broader economy.

A top holding in the portfolio is Brazilian Petroleum Corp.
PBR, -15.88%
"It has some of the best expectations going forward for its production growth," Smith said. "It also trades at about a 20% discount to this year's expected earnings."

It also owns Canadian-based Suncor Energy Inc.
SU, -0.39%
"They're the largest producer of oil from northern Alberta in Canada, where there are huge oil reserves," Smith said. "They've got a long pipeline, measured in decades, to support future growth."

The fund also is investing in Schlumberger, Ltd
SLB, -2.66%
which provides services to help producers draw more oil from fields along with various technologies to drilling and exploration companies.

Mike Breard, analyst at Hodges Capital Management, also believes that oil and other energy prices should keep rising in coming months. But he recommends careful stock selection to navigate through very volatile markets.

"It wouldn't surprise me if prices settled into a $75-$85 per barrel range by year's end," Breard said. "But it won't be a straight move up. This is a very volatile market."

So be prepared to take some lumps along the way, he said. "It's very difficult to play short-term fluctuations in oil. We're investing for long-term trends," said Breard, who helps pick stocks at the Dallas-based adviser to the Hodges Fund
HDPMX, -0.02%

The diversified multi-cap stock portfolio has gained around 8% this year. That's some 2.8% more than the broader market.

"Demand is slowing for some of the shallow water rigs. But there continues to be a shortage of deep offshore rigs in the world and day rates are going up," Breard said. "We see that trend continuing for at least the next five years. People have already signed leases for these deep offshore rigs going out to 2010."

He also likes many of the integrated oil producers, including Exxon Mobil Corp.
XOM, -2.20%
and ConocoPhillips
COP, -0.73%

Managers at Hodges are also favoring smaller, more speculative alternative energy plays. Those include Composite Technology Corp.
CPTC
which makes turbines for wind farms and cables for transmission of electricity over long distances.

The company is a micro-cap player. "There's a real need for modernizing the electrical grid in the U.S.," Breard said.

Composite Technology's cable is much more efficient as well as durable than conventional systems, he said. "And they sell a lot of their cable into China."

Roger Nusbaum, an independent money manager in Phoenix, Ariz., says that anything connected with Norway should benefit from rising oil prices. "It's the third largest non-OPEC oil exporter in the world," he said.

The largest company in Norway is integrated oil producer Statoil ASA
STO, +0.00%
"It's like the Exxon of Norway," Nusbaum said. "It has its hands in everything. They produce oil in the North Sea and they explore and produce oil all over the world."

The stock is up around 27% this year. In the past three years its shares have gained an average annualized 40%., according to Morningstar Inc., which tracks funds.

"The stock itself can be fairly volatile in shorter-term cycles," Nusbaum said. "But as a longer-term play on long-term increased energy demand globally, Norway is a great way to go."

Even at $60 a barrel, oil is still highly profitable to extract in the tar sands region of Alberta, Canada, he added. Nusbaum also likes Suncor. But he also suggests Petro-Canada
PCZ, +0.89%
for some of his high net-worth clients.

"It's less volatile than Suncor," Nusbaum said. "Petro-Canada isn't the biggest in tar sands reserves, but they're still a major player. And there are billions of barrels still be produced in that part of Canada."

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